The scale and scope economies, gain market control, economize

The reasoning behind mergers and
acquisitions (M&A) is that two companies together are more valuable than
two separate companies. The key principle behind buying a company is to create
shareholder value over and above that of the sum of the two companies. This
rationale is particularly alluring to companies when times are tough. Strong
companies will act to buy other companies to create a more competitive,
cost-efficient company. The companies will come together hoping to gain a
greater market share or achieve greater efficiency. Because of these potential benefits,
target companies will often agree to be purchased when they know they cannot
survive alone (Brigham, 1986; Cybo-Ottone and Murgia, 2000; Brealey and Myers,

The advantages stemming from
M&As have been evaluated in terms of the ability to exploit scale and scope
economies, gain market control, economize transaction costs, diversify risks,
and provide access to existing know-how. Nonetheless, empirical evidence on
M&As has also suggested that M&As might fail because of over-optimistic
expectations of benefits and underestimation of postintegration difficulties
like lack of market or technology relatedness, business culture clashes, etc.
(Ševi?, 1999). The two main approaches to tackle this issue empirically are
stock price studies and strategic management studies.

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Most of the empirical literature
on merger outcomes is based on stock price studies. These studies rely on
widely available information on stock prices and apply event study methodology
(i.e., to single out the effect of the announcement of M&As on stock price
performance by focusing on abnormal returns). A major drawback of this approach
lays in the fact that stock price movements rely on the anticipation of investors
as to the benefits and costs of M&As rather than on actual value creation (Vander
Vennet, 1996; Capron, 1999; Cybo-Ottone and Murgia, 2000; Beitel and Schiereck,
2001; Lepetit, Patry and Rous, 2004).

Conversely, studies of corporate
performance are less common because of the difficulty in collecting data and
constructing valid proxies for performance. An additional problem lies in the
difficulty of controlling other determinants when singling out the effect of
M&As on firm performance. Despite these limitations, the issues considered
by these approaches are pre-merger profitability, post-merger performance, and
who benefits most (the acquirer or the target company?) (Seth 1990).

Pre-merger profitability stream
of research focuses on the study of ex ante corporate performance in order to
identify potential acquirers and targets. Mueller (1980) in his summary of the
results on company performance studies concludes that there is a negative
correlation between performance and the probability of being taken over,
although the difference in performance is small and often non significant.

The acquirer is typically large,
and has higher growth and higher debt levels. Therefore, the weaker the
performance of a company, the more likely it is to become a target. Stock price
studies reach the same conclusions. This might suggest that the market for
corporate control is functioning properly with more efficient companies taking
over less efficient ones. The empirical studies looking at post-merger
profitability have mainly used data on stock market returns to assess
acquisition performance. In doing so, they focus on market expectations of
future cash flow growth in order to capture anticipated outcomes. Nonetheless,
these empirical investigations (belonging to the finance literature) have often
produced quite diverse results on the conglomerate post-merger performance. The
main problem is due to the type of data employed (stock market values) as
increases in shareholder value after consolidation may be too limited to confirm
efficiency gains. Other empirical studies investigate post-merger performance
by examining profit data by line of business (Ravenscraft and Scherer, 1987).
However, typically no improvement is detected on average after acquisition.

Finally, the phenomenon has been
further explored by using accounting data, but no convergent results have been
attained. The lack of convergence in the results has been attributed to a lack
of consistency in methodology, time frame, merger type, country, and sample
size used. In this respect, a step forward has been taken by Mueller (1980) who
examines acquisition performance in seven countries during the same period and
using the same indicators. Nonetheless, Mueller’s effort has not established a
consistent pattern either. No consistent improvement or deterioration in the
profitability of merging firms in the first three to five years following a
merger could be detected.

Empirical research has also
attempted to disentangle the performance of acquirer and target companies in
order to partition the gains from M. This issue has been mainly analyzed
in the corporate finance literature, using event studies. The evidence gathered
from this literature consistently favors acquired firms as the gains of the
acquirer are often found to be non-significant (Agrawal et al. 1992; Hayward and
Hambrick, 1997). This implies that acquiring firms often pay large amounts for target
firms gaining little or nothing from the announcement of an acquisition. Two
main issues arise in this context. First of all, it has been investigated
whether the difference in behaviors between the average target and the average
acquirer shareholder allows bidding firms to sustain their bids. The results
show that there is a

great variation in the acquirers’
performance following acquisitions, which suggests that this variation may be
more important than the average (mean) performance, and appeal to a more
risk-taking category of shareholders. Second, as part of the investigation of the
partitioning of benefits between a target and an acquirer, questions related to
anti-takeover provisions have arisen. In this respect, it has been shown that
management tactics to prevent takeovers reduce the probability of a takeover,
but raise the acquisition price if the takeover goes through. Therefore, if these
tactics favor shareholders of target firms, they damage shareholders of acquiring